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Ray Dalio's Short Puzzle for Bridgewater Is Missing Some Pieces

(Bloomberg Gadfly) -- Hedge fund titan Ray Dalio is famously enigmatic, but his latest wager may be the most puzzling yet.

Bloomberg News reported on Thursday that the fund Dalio founded, Bridgewater Associates, has made a $22 billion bet that many of Europe's biggest companies in the blue-chip Euro Stoxx 50 Index are poised to decline.

Bridgewater didn’t respond to Bloomberg’s request for comment, so Dalio's motivation is not entirely clear. But according to Bloomberg News’ Brandon Kochkodin, Dalio “has a checklist to identify the best time to sell stocks: a strong economy, close to full employment and rising interest rates.”

It’s an old idea. Economic fortunes are reliably cyclical, even if no one can precisely predict the turns. Booms tend to be followed by busts, and vice versa, and stock prices often go along for the ride.

By that measure, it seems like a precarious time for U.S. stocks. The U.S.’s real GDP has grown for eight consecutive years, by 2.2 percent annually from 2010 to 2017. Unemployment has declined to 4.1 percent from 10 percent in late 2009. And the yield on the 10-year U.S. Treasury is up to 2.9 percent from 2.1 percent in September -- an increase of nearly 40 percent.

The problem with Dalio’s checklist, however, is that stock prices take their cue from companies’ fundamentals, not the economy. Yes, companies’ collective fortunes often reflect those of the broader economy, but not always. And when the two diverge, the relationship between economic results and stock prices breaks down, too.

U.S. companies have done even better than the U.S. economy in recent years. Earnings per share for the S&P 500 Index have grown by 9.7 percent a year from 2010 to 2017, or real growth of 8 percent. That’s more than double the long-term earnings growth of 4 percent a year since 1871, and four times the real growth rate of 2 percent, according to data compiled by Yale professor Robert Shiller. It’s no surprise that the S&P 500 is up 11.6 percent annually over the last eight years through 2017.

Given the recent performance of U.S. companies, Dalio’s checklist of economic bellwethers might understate the risks to U.S. stockholders.

Consider, by contrast, how France and Germany have fared over the same time. The two European powerhouses dominate the Euro Stoxx 50 Index. Their companies account for 34 of the stocks in the index and 67 percent of its market capitalization in euros.

Like those in the U.S., Germany’s economic results check the boxes on Dalio’s list. Its real GDP grew by 1.9 percent a year from 2010 to 2017. Its unemployment rate has declined to 5.8 percent from 8.6 percent in early 2010 and is even lower now than it was before the 2008 financial crisis. And the yield on its 10-year government bond has nearly tripled to 0.9 percent since December.

France’s success has been more modest, but it, too, checks the boxes. Its real GDP grew by 1.3 percent annually over the last eight years. Its unemployment has declined to 8.9 percent from a peak of 10.5 percent in 2015. And the yield on its 10-year bond has nearly doubled to 1 percent since December.

Here’s the disconnect, however: Unlike U.S. companies, those in the Euro Stoxx 50 have performed horribly. Their revenue declined 1.3 percent annually from 2010 to 2017. They eked out earnings growth of 0.3 percent a year thanks to cost cutting.

Not surprisingly, stock prices have gone nowhere. The Euro Stoxx 50 is up just 2.1 percent annually from 2010 to 2017 in euros. That’s well below its annual growth of 5.3 percent from 1987 to 2009, the earliest year for which numbers are available.

As Bloomberg News points out, information about Bridgewater’s short bets on U.S. stocks isn’t available. It’s possible that Dalio’s skepticism is directed at U.S. stocks rather than European ones and that Bridgewater is betting that a U.S. bear market would drag down Europe, too. It’s a legitimate concern. During the previous two downturns in 2000 and 2008, stocks sold off around the world.

But if Dalio thinks that Europe’s economic numbers are concerning for its stocks, he may want to add a few more data points to that checklist.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Nir Kaissar is a Bloomberg Gadfly columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.

To contact the author of this story: Nir Kaissar in New York at nkaissar1@bloomberg.net.